Abstract
Venture Capital common knowledge is that companies with higher Gross Profit Margins are worth more than their relatively poorer performing counterparts. While this is intuitive, the reasonable question is: How much more? This blog entry documents a very simplistic analysis where high GPM% Analog-Mixed Signal (AMS) companies are compared with their more broadly defined Integrated Device Manufacturer (IDM) counterparts. The conclusion is that simply that for each 10% of extra Gross Profit Margin, the company's market cap approximately doubles.

Experiment
This analysis involves taking a small set of about 20 publicly traded semiconductor companies, breaking them into two groups, one representing the relatively small-cap Analog/Mixed Signal (AMS) companies and the other that represents a more broadly defined set of larger market cap companies. These groups are compared for Price (Market Cap) to Sales ratio (P/S) versus Gross Profit Margin percentage.

These companies were then subdivided into two groups, the first being the smaller AMS companies that are representative of the types of companies that are interesting for venture investing (yellow symbols) and the second representing a very broad view of the semiconductor industry (blue symbols).

Results
From the scatter plot shown below, the companies that occupy the upper right hand quadrant of the chart are mostly small-cap AMS companies. The companies that dominate the lower left hand quadrant are large-cap Integrated Device Manufacturers. There are a few poor-performing AMS companies below the line which are PowerDSine and Sigmatel and Silicon Labs.

One thing to note is that the R-Squared value (correlation coefficient) of these data for large cap AMS companies was much higher (~0.9) than the value for the total population of companies (~0.7). This correlation makes you think that the analysts simply look at GPM% and growth to forecast their valuation of AMS companies.

Conclusion
This work supports the idea that differentiated, high gross margin products are worth a lot more than commodities. The value of a company roughly doubles (1.9x) with each 10% increase in GPM%. A pre-IPO start-up company with 70% GPM could have a P/S ratio of 8x (assuming CFBE and reasonable revenue growth). While the small-cap AMS of companies have better statistics, they also are more difficult to predict. With all that said, small-cap AMS companies are better investments than their large-cap counterparts.